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A worst-case scenario for oil markets looks a reality as Iran takes steps towards shutting down the Strait of Hormuz following the destruction of its nuclear facilities following a U.S. bombardment.
The Iranian parliament on Sunday approved the closure of the Strait of Hormuz, through which about one-fifth of the world’s oil flows.
Iran’s security body will now make the final decision on whether to proceed with the plan, state television reported on Sunday.
Oil prices are set to surge, which will push the Pound to Dollar exchange rate lower. This is because oil is priced in USD, while demand for ‘safe havens’ – something the USD is considered – is set to surge.
“Currency markets could see a short-term bid for the U.S. dollar on safety grounds,” says Nigel Green, CEO of financial advisory firm deVere Group. “As markets reopen, investors are bracing for sharp volatility, with crude oil prices expected to surge and inflation forecasts now under intense scrutiny.”
The Pound to Euro exchange rate is also responsive to broader risk sentiment, with losses set to track declines in equity markets and the corresponding rise in volatility.
“Risk sentiment will remain a key market driver with FX investors closely following the latest geopolitical developments and efforts for a diplomatic solution of the Middle East conflict,” says Valentin Marinov, Head of G10 FX Strategy at Crédit Agricole.
Pound Sterling could meanwhile register gains against those currencies that are more sensitive to geopolitical risk, such as the New Zealand and Australian Dollars, Emerging Market currencies and Scandinavian currencies.
Above: GBP/EUR falls when stock market volatility (lower panel) spikes.
“The time for passive optimism is over,” says deVere’s Green. “This strike marks a turning point. The smart investors are already repositioning; those who hesitate risk being left exposed.”
On Saturday night, a group of American B-2 Spirit stealth bombers left Guam, a U.S. island territory in Micronesia, and hours later struck Iranian nuclear facilities.
After spending days deliberating taking military action, U.S. President Trump said the U.S. had targeted three nuclear sites inside Iran: Fordow, Natanz and Isfahan.
Iran has vowed to retaliate, and the biggest worry for markets could be about to be realised: the disruption of shipping through the Hormuz chokepoint.
“The Strait of Hormuz is key, where a fifth of the world’s oil and liquid gas flow through. For now, the impact of the conflict is limited, but we will assess the implications of a possible escalation once there is more clarity,” says Michael Widmer, Commodity Strategist at Bank of America.